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Sovereign Wealth to Move into Commodities, Oil

Sitting on up to $4 trillion in assets, much of it from selling oil and other raw materials, most SWFs have so far been conservative in their investment choices, holding dollars, treasuries and shares in large U.S. and European companies.

But they have been badly burned by the global financial and economic turmoil over the last 18 months and are now looking at new strategies to protect their interests, analysts say.

As these funds switch into commodities and oil those markets will be supported by the sheer weight of their purchases.

Surveys suggest SWFs may now have between $10 billion and $20 billion in commodities and oil, but this underweight by most measures could rise rapidly to hundreds of billions of dollars.

“The potential for growth is absolutely massive,” said Amrita Sen, analyst at Barclays Capital in London and co-author of a report this month on sovereign wealth funds and commodities. “They are waiting for the right signals. They want to see the economy beginning to bottom and that oil has turned.”

SWFs, notoriously secretive and with few published figures -- have existed since the 1950s but they have grown dramatically in the last decade and are now run by more than 30 countries.

Some such as the Government of Singapore Investment Corp (GIC), which has an $300-350 billion in assets, have taken a fairly conventional approach to fund management, holding bonds, dollars, other major currencies and taking stakes in companies.

Others, such as China’s $200 billion sovereign wealth fund, China Investment Corp (CIC), have taken strategic stakes in companies with key hard assets. Australian iron ore miner Fortescue Metals Group said last week it talking to CIC and China’s Baosteel on the possible sale of iron ore assets.

Until recently, most SWFs have avoided direct investments in markets for raw materials such as oil and other commodities.

Part of the reason for this is that almost two-thirds of their wealth comes from oil. Some of the biggest SWFs are run by oil-exporters such as Abu Dhabi, Kuwait, Dubai and Brunei.

Norway, the most open SWF with assets of more than $300 billion, deliberately avoids investments in oil and gas in an attempt to diversify away from its dependence on hydrocarbons.

But analysts say the relatively conventional investment strategies of SWFs led them to huge losses in dollar-denominated assets between 2002 and 2008 and they have also suffered badly from the plunge in stock markets over the last two years.

Many of them also missed out on the commodities boom of 2007/08 and the rally in oil prices that peaked last year.

Now an extra concern is pressing a reassessment of strategy: the spectre of inflation from next year once the impact of loose monetary policies now being put in place take full effect.

“These type of funds hold a long macro view,” said Harry Tchilinguirian, commodities analyst at BNP Paribas. “The level of monetary push is unprecedented and if they are looking one to two years down the line, inflation becomes a real concern.” Gold has been a recent beneficiary of a switch towards alternative investments and there is also evidence that some SWFs have been moving indirectly into oil via exchange-traded funds (ETFs) and some structured products.

The world’s largest gold-backed ETF, SPDR Gold Trust, said holdings hit a record 1,028.98 tonnes on Feb. 19 and ETF Securities has reported a series of record inflows into gold.

“Commodities are one of the few effective hedges against inflation,” said Nicholas Brooks, head of research at ETF Securities, which issues exchange-traded commodity securities for oil, gold and commodities such as agricultural products.

Most analysts believe the funds have substantial holdings in gold, either via ETFs or by owning bullion directly, and they say that SWFs are looking at buying oil using similar vehicles.

Industry estimates suggest SWFs now have very little exposure to commodities and oil — probably less than 0.5 percent of their almost $4 trillion in assets. A fall of more than 70 percent in prices since last year’s record peak around $150 per barrel has kept many funds away from oil, and the global economic downturn and consequent losses have encouraged very conservative investment strategies.

But any sign of economic recovery, or, for example, an upturn in the oil market, would encourage a move towards a much greater allocation to alternative investments such as oil.

Most allocation models suggest funds should be looking at putting at least 5 percent of their assets into commodities and oil, which would mean a 10-fold increase to around $200 billion.

Brooks at ETF argues that even that figure could be too low and sees 10 percent as a more appropriate target: “That’s an awful lot of money waiting to come into these
 markets.”